5/04/2011 @ 6:00PM

REIT Merger Boom Is Brewing

In 2010 real estate watchers became very excited about two potentially big trends: initial public offerings and mergers and acquisitions. Unfortunately the consolidation wave never materialized, and the new stocks that were offered seriously lagged major REIT indexes. Last year investors stuck with the established REITS that had made it through the downturn, as they raised $47.7 billion in secondary stock offerings and unsecured debt. Overall REITs had a total return of 28%. As a group they snapped up $25 billion worth of individual properties.

The REIT IPO market is still struggling, and only two private property companies have completed offerings this year. Both are now well positioned to reap the benefits of access to faster, cheaper public market capital.

American Assets Trust (AAT, 22) raised more than $500 million in January, and since then its stock is up 7%. American Assets is a 45-year-old company based in San Diego that has a high-quality diversified portfolio of office, residential and retail properties. Its California and Hawaii portfolio is just 5% vacant–despite a national average in the double digits. In March it made an all-cash acquisition of a top-quality office building in Portland, Ore. leased mainly to government agencies. The deal structure brought in an exceptional yield of nearly 7%. While managing a diverse portfolio isn’t for every REIT–or for most–American Assets’ management group is experienced and capable.

Summit Hotel Properties (INN, 11) is yet another in a string of hotel REITs that have IPOed since 2009, including Chesapeake, Pebblebrook and Chatham. While I don’t usually go for the amenity-light midscale chain properties that make up Summit’s portfolio, it, too, has smart management that is experienced in this sector at a time when hotel buyers are fighting over so-called full-service hotels known as luxury, boutique and convention center properties.

The not-so-glitzy but cash-flowing hotels that Summit owns make up almost half of the hotel market. Most investors are ignoring the group even as the hotel market has recovered. Summit, with cash on hand, is staking out this territory and is likely to grow rapidly in size–and in dividend yield. Summit came public in February at $9.75 per share and is already up 15%. It’s still cheap.

One long-planned and now scrapped IPO is Eola Capital. In early April Eola announced it was selling itself to Jackson, Miss.’
Parkway Properties
(PKY, 17), an office REIT with holdings mostly in the Southeast. The move allowed Eola to bypass the offering process–but since its management team is moving to Parkway and has a big incentive to expand business, I expect more acquisitions. Parkway has always been a middle-of-the-pack company, but the deal adds new capital, heft and fresh perspective at a promising point in the office market’s recovery, both in terms of property prices and operating fundamentals.

It’s my belief that a merger wave is finally coming to the REIT market. So far this year a number of industrial, office and health care REITs have either merged or made acquisitions, and the stocks of those involved, such as
AMB Property
and Nationwide Health, have outperformed their peers. This tells me that Wall Street is looking favorably on such combinations.

Surprisingly there have been no mergers yet in the apartment or hotel sectors, where fundamentals are improving more rapidly than in any other property sector. Two hotel companies whose portfolios would fit well together–or easily fold into those of a high-quality owner–are
DiamondRock Hospitality
andAshford Hotels. Ashford has aggressively cleaned up its balance sheet and is poised for growth or a merger. Of the two, buy Ashford HOSPITALITY TRUST (AHT, 12).

On the apartment side
Camden Property Trust
(CPT, 62) and
Mid-America Apartment Communities
(MAA, 66) have significant Southeast and Southwest exposure that could lure one of the larger apartment REITs, such as
Equity Residential
, into expansion mode. Both are buys, and neither has experienced the strong gains of Equity Residential.
BRE Properties
has great assets on the West Coast but hasn’t kept pace with other leading coastal apartment owners like
Essex Property Trust
, which I have recommended before. Hold off on buying BRE.